Deep Dive: BlackRock (BLK)
Deep Dive: BlackRock (BLK)
Breaking down the world's largest asset manager
BlackRock is the largest asset manager in the world, and its Founder/Chairman Larry Fink arguably the most powerful person on Wall Street. Everyone has heard of BlackRock, but surprisingly few – even professionals who work in asset management – know about the business other than being a prolific asset gatherer.
But what sort of competitive advantage has the firm built to grow consistently for three and a half decades in asset management (an industry where success is often short-lived)? Why is BlackRock considered the original “Fintech”? And is BlackRock now finally too big to grow? To answer these, we draw on plenty of commentaries from interviews with BlackRock’s former employees, including Managing Directors, in this report.
BlackRock at a quick glance:
As of December 2022, BlackRock had AUM (assets under management) of $8.6tn. A year ago, it had over $10tn. Since 2012, AUM grew at a CAGR of 9%. Taking a closer look:
While BlackRock started as a fixed income house, today more than half of AUM comes from equities, fueled by the growth of equities ETF (BlackRock iShares).
But make no mistake - BlackRock is not just an ETF house. Actively managed strategies accounts for almost a third of AUM, and contributes to half of the firm’s total revenue. Importantly, BlackRock’s performance in active strategies have been good (especially 3 and 5-year returns).
Revenue breakdown roughly mirrors that of AUM breakdown. Alternatives clearly punches above its weight contributing to 11% of revenue (13% if performance fees included) with only 3% of AUM.
Not included in the breakdown above is a separate ‘Technological Services’ segment which generated revenue of $1.4bn (7.6% of firm total). This includes external revenue from Aladdin, BlackRock’s portfolio and risk management software built in-house. But the importance of Aladdin to BlackRock is much higher than its revenue contributions suggests, and in fact so important that it deserves to be the centerpiece of this report.
Becoming BlackRock
As prominent as Larry Fink is now, perhaps lesser known is his early career. Fink had a meteoric rise as a star fixed-income trader at First Boston, becoming the company’s youngest managing director at the age of 31. Having ‘made it’ at a young age, Fink became emboldened by his success. His desk was the most profitable trading desk at First Boston. That is, until 1986, when he made a failed bet on interest rates which blew up and ended costing his desk $100 million in a few days. In Fink’s own words:
“At 31 I became the youngest managing director at First Boston, and at 34 I became an asshole” – Larry Fink
His career at First Boston never recovered. He ended up leaving the firm two years later, in 1988.
Fink attributed his failure to a lack of risk management. After leaving, he partnered with seven other co-founders and started a new asset management firm. This time around, Fink vowed to emphasize risk management at the heart of the company. So BlackRock was born.
Except, in the early days it wasn’t called BlackRock. Steven Schwarzman’s BlackStone took a 40% equity in Fink’s new venture (in exchange for a $5 million line of credit). In 1994, Fink’s firm split off from BlackStone and named itself BlackRock – paying homage to its former parent. BlackStone sold its stake in BlackRock, (then valued at $240m) to PNC Bank, a regional bank based in Pittsburgh. PNC folded its own asset management operations into BlackRock and then listed the combined entity in 1999. At the time of the IPO, BlackRock was already a giant that was managing $165bn primarily in fixed income.
While most of the AUM was in fixed income at the time, BlackRock also began to expand into equities. Notably, BlackRock grew by a series of successful M&As. Successful M&As are a rarity, but especially in asset management where it’s more about people and culture. In 2004 BlackRock acquired State Street Research & Management for $375mn, which bolstered the firm’s equities business. In 2006 it acquired the distressed assets of Merrill Lynch Investment Management. But Larry Fink’s biggest bet would be in 2009, when BlackRock acquired Barclays Global Investors – including the iShares ETF unit which was its crown jewel - in a $13.5 billion deal.
Fink astutely took advantage of the buying opportunity created after the Global Financial Crisis. iShares was the crown jewel of Barclays, but Barclays had been pressured to sell it in order to avoid a UK government bailout. This was a bold move by Fink. It was unconventional at the time to bring active and ETF businesses under the same roof - these two were different businesses with very different cultures. Fink’s foray into ETF demonstrated his long-term vision, but perhaps more impressive was his willingness to essentially disrupt itself to ensure BlackRock’s success.
When asked about what his firm’s secret sauce is, Larry Fink often answers “culture”. This must sound cliché to most people. But what came as a surprise as I was going through interviews with former BlackRock employees was the sheer positivity of comments about the firm’s culture. By the time I had gone through eight interviews, I could not find anything other than the highest praise for the firm’s culture, which can pretty much be summed up as an enormous ‘sense of fiduciary duty’ and a ‘focus on risk management’.
(Keep in mind the passages below are interviews with former employees, not paid PR spokespersons!)
“I will say that the thing that I was most impressed with in my time at BlackRock is lots of organizations talk about or talk the talk about the importance of their clients. I really actually felt that every day at BlackRock. The intensity of the client relationship and your fiduciary obligation within that relationship is something that's massively impressive about BlackRock. I can give you a whole litany of things that are what I would call micro problems at BlackRock, but at a macro level. Their focus on their clients is absolutely very impressive.”
“I can’t stress enough how seriously BlackRock treats client relationships, and the business development function at large. Anywhere you go at BlackRock, literally any office in the world and you ask any person, clients always come first, and a client’s trust is sacrosanct”
“Can't say enough great things about the firm. Over 15 years, BlackRock has been very good to me and I've gotten to see all of its ins and outs in every aspect of the business. I've touched almost every possible part of the firm. I think the world of the leadership team, the people there, the infrastructure, certainly, the Aladdin backbone, we call it the central nervous system that underlies everything we do at BlackRock. I'm not there currently, but very much there in spirit and continuing to cheer it on because it's a world-class organization.”
The Original ‘Fintech’
BlackRock doesn’t call itself this, and nor do investors, but the truth is that it’s more of a fintech than most of the companies that investors consider “fintechs” out there in the market today.
BlackRock is a first-rate investment organization, but its stock picking (or bond picking) prowess alone didn’t make it into what it is today. BlackRock’s senior management considers technology their right-to-win in the industry. This is interesting as most asset managers are bad with technology!
As an analogy, if asset management is a factory, then Blackrock operates the largest, most data-driven and sophisticated factory. It’s a factory that produces not physical goods, but risk management insights. By opening up the Aladdin platform to other large asset owners like insurance companies and pension funds, BlackRock has accumulated the largest dataset in the industry. With risk models that have been crisis-tested and refined for over three decades, Aladdin is the industry leading risk-management platform.
So what’s the significance of this for an asset manager? Consider the fact that BlackRock works closely with the C-suite and the boards of the largest pension funds and endowments in the world. These key decision makers are most concerned with risk management above all - answers to questions like: “What’s going to happen to my portfolio if X happens in the world?” or “How to quantify the risk that I can’t meet my future liabilities?”. Leveraging its technology platform, BlackRock is able to provide answers and solutions to these kinds of questions. Whatever BlackRock proposes, it’s able to back them up with data. The result is that BlackRock has earned a reputation as a risk consultant to the largest asset owners globally. With technology, BlackRock has built a ‘right-to-win’ platform in asset management.
Aladdin – “Asset, Liability, Debt and Derivative Investment Network”
“To really understand BlackRock, you need to understand Aladdin”
– Rob Goldstein, COO
As we discussed, Larry Fink made it very clear from day one that risk management should lie at the heart of BlackRock. Aladdin started as BlackRock’s in-house risk management tool for fixed income. As BlackRock’s investment operations grew in scale and expanded into other asset classes, so did Aladdin. Risk management still lies at the heart of Aladdin, but it’s now hardly just a risk management software. It handles everything from pre-trade to post-trade, covering back, middle, and front office. BlackRock employs 4,500 technologists (out of a total workforce of 18,000).
“Most people that know the firm either from having been in it or following it closely, know that it is religiously disciplined and hyper-focused on downside risk mitigation which spans investment risk, credit risk, compliance risk, regulatory risk, etc. Aladdin is heavily dedicated to this”
Aladdin came out of solving BlackRock’s internal risk management needs. For about ten years it was used exclusively internally. Then in 1999, BlackRock made the big decision to open it up, and started selling subscription to external clients which were mostly other big money managers and asset owners like insurance companies and pension funds. Sounds familiar? This is much like Amazon with AWS.
So Aladdin is valuable to BlackRock as both an internal tool (with BlackRock itself as the largest and most sophisticated user of Aladdin) and an external revenue-generating SaaS business. And these two are closely related. For example, BlackRock, as the largest and most sophisticated asset manager, is the main driver of innovations and new features on Aladdin. As one former employee has said,
“Anything Blackrock wants, most likely every other client’s going to want that a couple months down the road”
Let’s talk about why Aladdin is appealing to external customers. Aladdin’s key value proposition is “one company, one platform, one data set”.
“It’s a framework that supports the entire asset management lifecycle from risk management through portfolio construction, through, if you will, client statements and regulatory, and it supports all of the various instrument types. The key thing about Aladdin is, it’s a single database where all of the applications run off of the same data sets, which is what its real power is”
– Former Director, Aladdin Product Group (Sep 2022, Stream Transcript)
Most financial services firms juggle software from multiple vendors. The alternative to Aladdin would be to use different software for different parts of the business – for example Charles River for trading, Geneva for portfolio accounting, another one for regulatory reporting, and yet another one perhaps for portfolio construction. Some may be internally developed as well. The problem is that all of these software work off of different datasets and are not designed to talk to one another. Firms have tried to stitch up products from different vendors, but the more integration work involved, the more process risk that’s created. Siloed risk management can turn into disasters for organizations, not to mention the cost and burden on the IT department for having to manage multiple vendors. Aladdin provides an all-in-one seamless solution.
BlackRock has been a major driver for this single vendor model which has been gaining popularity. Others have followed – State Street acquired Charles River Development in 2018 which combined Charles River’s front-office software with State Street’s back and middle office, essentially validating the single platform/vendor model. There are three major players today (BlackRock, SimCorp, State Street) offering end-to-end solutions. While the precise market share breakdown is not known, BlackRock is believed to be the largest. An MD of SimCorp North America said he sees SimCorp’s Dimension platform and BlackRock’s Aladdin as “the only game in town”. Another competitor says BlackRock is in the lead and “it will be hard to catch them unless they lose their focus”.
How powerful and significant is Aladdin?
“One of the greatest examples of the power of Aladdin was, in the 2008 Financial Crisis on Saturday and Sunday when Lehman Brothers went under, all of Aladdin investment management clients had a report on their desk on Monday morning showing their exposure to Lehman across all of their holdings, whether it was Lehman as broker, they had Lehman investments, etc., and it was the only firm that had a true handle on what people held and where it was, which is why the Federal Reserve and a lot of countries came to BlackRock to help them manage themselves out of the financial crisis.”
– Former Director, Aladdin Product Group (Sep 2022, Stream transcript)
“(after 2008 financial crisis) We were called in by the Federal Reserve Bank of New York to facilitate the rescue operations of Bear Stearns and AIG…we were among the only advisors in the world who could make sense of these assets, provide actionable advice to our clients, and also possessed the trading infrastructure to execute on behalf of our clients when asked”
The power of Aladdin is evident. But if it’s so good, why does BlackRock not keep Aladdin proprietary?
Now this is where it gets even more interesting. Risk models benefits from having more data. And one way BlackRock can obtain the most complete dataset in the industry is by allowing others, including even its competitors, to use its software. It’s been reported as of 2020 that $21.6tn in assets sits on Aladdin, and this comes from just a third of Aladdin’s 240 largest clients.
Bigger datasets mean better visibility into systemic risks, allowing it to create better models. This is a moat that’s growing over time as Aladdin reaches more users, and as risk models get tested through market crisis and are continuously refined and improved upon. If Aladdin is the dominant risk management platform today, I would wager that in ten years there will be even less competition.
At this point, astute readers may ask: isn’t there a conflict of interest? Why would users of Aladdin, some of which are BlackRock’s competitors, trust BlackRock with their own data? This is certainly a valid concern that is shared by some users. To mitigate this issue, there is a “Chinese wall” within BlackRock that makes sure that while client data can be used for the purpose of refining Aladdin’s models by the technology group, it can’t be used by Blackrock’s investment department to trade against their client positions.
“There’s really strict protection in terms of who can see what. Honestly, even just the permissions of who has access to certain pages and so far they (BlackRock) haven’t messed up, so they’ve got a pretty good track record on that. It’s something that they’re just upfront about. For the most part, pretty big asset management firms that I worked with through Blackrock have been okay with that. Their lawyers have been okay with that.”
Even with this kind of potential conflict of interest, the fact that BlackRock’s competitors are still using Aladdin is a testament to the importance of the software and the software’s lead over other competing solutions. For example, Vanguard, BlackRock’s biggest competitor in the ETF space, is an Aladdin user. Importantly, it also shows the kind of reputation and trust that BlackRock has built in the industry.
Growing Aladdin